№2(13)(2013)

In this article we will talk about how to account and tax contributions of non-resident founders to authorized capital in foreign currency. It would seem simple: when decided to create an enterprise - simply registered share capital, made contributions and started working!

But in our time "simply" does not happen, everywhere lies a catch. Let's start from beginning, from the time when two individuals (and possibly legal entities) have a desire to start any business, and one of participants is resident of Ukraine, the other - non-resident.

Registration

In accordance with art. 87 of the Civil Code of Ukraine from 16.01.2003, № 435-IV (hereinafter - the Civil Code), in order to create a legal entity, its members (founders) are developing constituent documents, as set out in writing and signed by all participants (founders). Founding document of company is as approved by statutes or memorandum between parties, unless otherwise provided by law.

According to art. 390-391 of the Commercial Code of Ukraine from 16.01.2003, № 436-IV (hereinafter - the Commercial Code), foreign investors can be:

- Legal entities that are established by rules of any other law than the law of Ukraine;

- Foreigners and stateless persons who have no permanent residence in territory of Ukraine;

- International governmental and non-governmental organizations;

- Other states;

- Other foreign entities investing activities as defined by law.

Foreign investors have right to invest in form of:

 foreign currency (convertible by the National Bank of Ukraine);

 any movable and immovable property, and related property rights;

 other values ​​(assets), which in accordance with law, are recognized as foreign investment.

According to art. 393 of the Commercial Code, the foreign investment assessment, including contributions to authorized capital of enterprise with foreign investments is made in foreign convertible currency and in UAH, by agreement of the parties, based on prices in international market or market of Ukraine. While exchanging foreign currency into hryvna is done at the rate set by the National Bank of Ukraine.

Funds’ contribution

NBU Regulation № 280[1] sets that foreign investment in Ukraine in form of money is allowed to perform in UAH and foreign currency only from 1 group of classifier. According to the Classifier of foreign currencies[2] freely convertible currencies that are allowed to invest in Ukraine are: Australian dollars, British pounds, Danish kroner, U.S. dollars, the Icelandic krona, Canadian Dollars, Norwegian Krone, Swedish Krona, Swiss Franc, Japanese Yen, euro.

In turn, authorized bank is to enroll foreign currency transferred from abroad at investment account of foreign investors-legal entity through distribution account.

State registration of foreign investments

According to art. 395 of the Commercial Code, state registration (re-registration) of foreign investment and its cancellation is done by Council of Ministers of Crimea, regional, Kyiv and Sevastopol city state administrations in order determined by the Cabinet of Ministers of Ukraine, within seven days from the day when foreign investor presented documents for such registration (re-registration) of foreign investment or its cancellation.

Order of state registration of foreign investments is established by the Regulations № 928[3], according to which foreign investor or authorized person for state registration of foreign investments present certain list of documents required for such registration to state registration office (section 3 of Regulations № 928).

We shall note that there is no responsibility provided according to valid legislation for the foreign investments non-registration. However, one should remember that, according to art. 395 of the Commercial Code, unregistered foreign investments do not qualify for benefits and guarantees provided by this Code and other laws for foreign investors and enterprises with foreign investment. This restriction applies to exemptions from payment of customs duty of property imported into Ukraine as contribution of foreign investor in authorized capital of enterprise with foreign investments. Thus, in accordance with part 2, art. 287 of the Customs Code of Ukraine from 13.03.2012, № 4495-VI, goods imported into Ukraine as contribution of foreign investor to authorized capital of enterprises with foreign investments (except for goods for sale or used for purpose not directly related to business activities) shall be exempt from customs duty.

Accounting

In accordance with the provisions of the Instruction № 291 account 40 "Share capital" is used for registration and compilation of information on status and movement of share capital of company. Credit of account 40 "Share capital" reflects its increase, debit – its reduction (withdrawal). Balance in this account must match sum of share capital, which was reflected in founding documents of enterprise.

According to par. 5 of RSA 21 "Effects of Changes in Foreign Exchange Rates"[4], foreign currency transactions on initial recognition are recorded at exchange rate at the date of transaction. In fact, contribution to authorized capital of foreign company is a non-monetary item of balance sheet and therefore not subjected to reassessment due to changes in exchange rate (which is also confirmed by the Ministry of Finance in a letter from 20.08.2012, № 31-08410-07-25/20605).

Thus, contributions of participants in authorized capital of company are estimated and recorded in founding documents in Ukrainian hryvna at the rate of NBU on date of signing statute and will not be restated due to changes in foreign exchange rates.

As for information on changes in unpaid capital, according to Instruction number 291, it is stated at account 46 "Paid-in capital". Debit of this account reflects receivable to authorized capital of company from its founders (participants), credit – the debt on contributions to its capital repayment.

As to reflect the amount of foreign currency debt of foreign investors on capital contribution, accounted in debit of account 46 "Paid-in capital," opinions of experts has differed in terms of determining monetary or non-monetary essence of this article’s balance, as well as accounting for differences arising from debt recalculation at the date of balance and on maturity date.

There are a couple of options for accounting differences arising on foreign currency debt:

1) reflecting differences arising from recalculation on the balance sheet date / maturity date as part of other income / expenses (account 74 "Other income" and 96 "Other expenses" respectively);

2) recognizing differences only in additional capital (in account 42 "Additional Capital").

For example, some experts believe account "Paid-in capital" to be a non-monetary balance sheet item, which can not be recalculated due to changes in foreign exchange rates. Reasons in this case are norms of R(S) A 21, according to which monetary balance sheet items are those items of cash, of assets and liabilities that will be paid in fixed (or certain) amount of cash or cash equivalents. That is because the balance sheet item "Paid-in capital" refers directly to accounts of equity, then it can not be monetary item. Therefore, differences that occur at the time of contribution repayment by investor to authorized capital must be considered in accounts of other income / other expenses.

Second option of accounting the exchange differences on founders-non-resident contributions is their record on account 42 "Additional capital", which, according to the Instruction № 291, is intended to summarize information on amounts in which the value of issued shares exceeds their face value, on revaluation surplus for non-current assets and financial instruments, fixed assets value which company obtained from other entities for free, as well as other types of additional capital.

The Ministry of Finance tried to dispel doubts of experts in letter from 20.08.2012, № 31-08410-07-25/20605, which states that "exchange differences on contributions obligations of non-resident founders to authorized capital of company, which must be in foreign currency, in accounting are to be recalculated using exchange rate at the balance sheet date. Exchange differences are not defined on the date of transaction to repay debt of non-residents to authorized capital in foreign currency".

Accountants were even more confused after this letter of MFU, as it turns out, that exchange differences sort of arise, but are converted only on the balance sheet date, and not on the date of repayment...

Therefore, we have sent a request on this issue to the Ministry of Finance to clarify how to account exchange differences arising from recalculation of participants’ debt obligations in formation of authorized capital. We received the following reply from MFU: "According to the Regulation (Standard) of Accounting 3 "Income Statement" approved by Order of the MFU from 31.03.1999 № 87, incomes are increases in economic benefits in form of incoming assets or decreases of liabilities that result in equity increases (other than capital growth through owners contributions) for the reporting period. Accordingly, exchange differences that arise as result of recalculation participants debts in formation of authorized capital, can not be recognized as income. Therefore, amount of such exchange differences is recognized in additional capital".

Frankly, it is hard to disagree with that opinion of experts, because, truly, arising exchange differences related to foreign currency debt of non-resident founders can not be counted as income or expenses of enterprise, as they do not lead to an increase (decrease) in economic benefits during the reporting period.

Thus, we conclude that second alternative accounting way of exchange differences on contributions of non-resident founders, namely their record on account 42 "Additional Capital", is correct.

Tax accounting

According to p.p. 196.1.1 of TCU operations on corporate rights issuing are not subject to taxation of VAT, so the VAT obligations of such transactions do not arise in company.

According to p.p. 136.1.3 of TCU amount of cash or property value, which come to taxpayer in form of direct investment or reinvestment in corporate rights issued by such taxpayer, are not included in taxable income under determination of the tax object in income tax. Therefore, amount of cash in foreign currency received by enterprise from the non-resident founder as contribution to authorized capital, do not lead to tax revenue.

Based on p.p. 153.1.3 of TCU, defining exchange differences from transactions recalculation denominated in foreign currencies, debt and foreign currencies are carried out according to Regulations (Standards) of Accounting. In this case, positive exchange rate differences are recorded in taxpayer income, and negative exchange rate differences - in taxpayer expenses.

Here we could complete our consultation since we have already considered the accounting of exchange differences on recalculation of participants’ debt in capital formation, and determined that such differences can not be recognized as enterprise income or expense. However, there are some controversial and unresolved issues in tax accounting.

For example, Single database of tax knowledge (section 110.13) contains following clarification on this issue, "foreign currency which is not paid to authorized capital as a monetary item of balance sheet (cash to be received in a fixed amount of money) is subject to recalculation. Thus, a positive or negative exchange rate differences are calculated between official exchange rate of national currency to foreign currency at the date of acceptance of such indebtedness and official exchange rate of national currency against foreign currencies at the reporting date or the balance on the maturity date of such debt, depending on events that occurred before".

But the latest Generalizing tax advice regarding definition of exchange differences on recalculation of foreign currency transactions, debts and foreign exchange, approved by the Order of STSU from 05.07.2012 № 574, it is determined that exchange differences  are not recalculated on foreign investments. It is possible that regulatory authorities tried to get close with opinion of the Ministry of Finance on exchange differences accounting arising on non-resident participant debt in foreign currency. And perhaps, this consultation purely talks about the investment value, rather than debt on it, ie, about account 40 "Share capital", on which exchange differences are not recalculated.

Of course, one can not built tax accounting on guesses, so we recommend careful taxpayers to apply to the tax authorities for an individual explanation and to get clear opinion from tax authorities, in case of positive exchange rate differences – to include them in income, but we suggest to wait with inclusion of negative exchange differences values and do not represent them in tax accounting. Since, in accordance with paragraphs 14.1.27 of TCU, costs are amount of any expenses of taxpayer in monetary, material, intangible forms .., resulting in decrease in economic benefits in form of assets outflow or increase in liabilities, resulting in decrease of equity (except for changes in capital through its withdrawal or distribution by owner). As for the definition of "income", according to par. 14.1.56 of TCU income is total amount of taxpayer income from all activities received (gross) during reporting period in monetary, material or intangible forms on the territory of Ukraine, its continental shelf and exclusive (maritime) economic zone and beyond. Thus, proviso "except for changes in capital through its withdrawal or distribution by owner" is missing in this definition of "income".

For less cautious taxpayers main reasons in this favor on non-inclusion of income and expenses from differences that arise by conversion of debt of non-resident participants in foreign currency will be the following:

- Requirements of paragraphs 153.1.3 of the TCU in terms of exchange differences accounting according to R (S) A;

- Norms of R (S) A #3 in terms of definition of "income" and "expenses";

- Explanations given in the Generalized tax advice, approved by the Order of STSU from 05.07.2012 № 574 (the answer to question # 7, "exchange differences on foreign investments are not recalculated").

Example: Resident enterprise Statute is approved in amount of $10 000, according to NBU rate on the date of signing (10.01.2012) - 7.95 UAH per $ 1 - is 79 800,00 UAH. Owners’ shares are distributed as follows:

- Non-resident - 70% ($ 7000.00 or 55650.00 UAH);

- Resident - 30% ($ 3000.00 or 23850.00 UAH).

According to the participants meeting protocol, participants contribute their shares in cash.

01/12/2012, resident transferred to enterprise’s p/a 23,940.00 UAH.

01/14/2012, non-resident transferred foreign currency to enterprise’s p/a in the amount of $ 5000.00.

04/05/2012, non-resident repaid the balance of outstanding contributions in the amount of $ 2000.00.

NBU rate is:

- On 14.01.2012 -7.98 UAH for $ 1;

- On 31.03.2012 - 7.93 UAH per $ 1;

- On 05.04.2012 - 7.90 UAH per $ 1.

Table 1

Accounting of contributions of the non-resident founders to authorized capital of resident company

* in accordance with Generalized tax advice № 574, exchange differences on foreign investments are not recalculated in tax accounting